Equity Crowdfunding on Its Second Birthday: A Look Back and Ahead
Title II of the JOBS Act recently passed its second birthday, which makes it an opportune time to take a look at the sector to date, as well as attempt to chart where it is going.
This new public-facing financing method became possible on September 23, 2013, when the Securities and Exchange Commission (SEC) put into effect Rule 506(c) of Regulation D of Title II of the JOBS Act. This rule allowed private companies to advertise their securities offerings to accredited investors. Previously, such public solicitation and advertising was prohibited. Entrepreneurs can now publicly market their securities offerings through crowdfunding platforms such as AngelList, CircleUp, Crowdfunder and Portfolia.
The Floodgates Didn’t Exactly Burst Open
Over the course of the past two years, nearly 5,600 companies have sought capital publicly, and nearly 1,400 succeeded in raising money, according to Crowdnetic, which aggregates data from 18 equity crowdfunding platforms.
This success rate of about one in four companies is similar to the success rate in the offline world. These companies raised more than $600 million combined, averaging about $447,000 per company. While these numbers sound impressive, only a tiny percentage—2%—of money raised from accredited investors has been raised via equity platforms using 506(c) in 2014.
What’s Holding Equity Crowdfunding Back?
Several reasons have contributed to equity crowdfunding’s slow start, but many are fading out of rear-view as the movement gains momentum.
A Steep Learning Curve
Some viewed equity crowdfunding's complexity as a disadvantage. The advantages of publicly raising capital, however, can move you past its disadvantages. Publicly raising capital widens the pool of potential investors from just people you know to any accredited investor, shortens the length of time it takes to raise money and both centralizes and streamlines the fundraising process.
In contrast, raising money offline can take seven to 12 months, sometimes even longer. On average, it takes four to six months on crowdfunding sites, according to Luan Cox of Crowdnetic.
Emerging best practices are flattening the learning curve by shortening the time it takes to bring yourself up to speed. Here are articles on lessons from the field and ways to ensure a successful campaign as well as a research report on the topic, Stand Out In the Crowd: How Women (and Men) Benefit From Equity Crowdfunding.
A Lack of Understanding
Some lawyers and CPAs don’t have an understanding of 506(c). As a result, they have a lot of misconceptions about it, and are advising their clients not to raise money publicly. I’ve tackled the most common misconceptions here.
Many angels have a bias against equity crowdfunding, believing the best deals can only come through personal referrals. “They don’t understand its value,” says Barbara Clarke, an angel investor who has invested in a crowdfunding platform, Portfolia. “It’s about increased deal flow, convenience and transparency. Many angel groups use online platforms, but a lot of the due diligence is done through email, and things get lost. With equity crowdfunding platforms, everything is centralized, all in one place. I can look at it when it is convenient for me.”
The Potential for Abuse
There has been concern over the potential for abuse by bad actors. “There will be missteps, but the good news is that in the first two years since Title II was implemented, there hasn’t been any fraudulent behavior,” according to Douglas Ellenoff, a partner at Ellenoff Grossman & Schole, a leading securities and crowdfunding law firm.
Big Things Are Happening (and More Are in the Works)
Growth in equity crowdfunding is being propelled by current activity, as well as opportunities just beyond the horizon. For example, asset managers have been closely watching the sector to understand how they can take advantage of 506(c).
“Institutional players recognize the opportunity that 506(c) allows,” says Kim Wales, founder and CEO of Wales Capital and CrowdBureau and a pioneer in the crowdfunding industry. “Prior to Title II you could only invest in a deal if you had a prior relationship. Now any accredited investor who reads a tweet or ad in a newspaper can invest.”
Syndicates, Partnerships and Alliances Are Moving the Needle
Some investors are skipping the toe test and instead just dive right in. AngelList announced a deal with CSC Venture Capital to launch CSC Upshot, a $400 million fund for early-stage startup investments. It will primarily invest in syndicates, which allow investors to co-invest in deals led by experienced angels and venture capitalists (VCs). CSC Upshot adds to the $205 million already invested through syndicates via AngelList. More than 650 startups have raised money from syndicates, including Shyp, Sprig and Luxe.
Cintrifuse, which aids Cincinnati-based high-potential startups, is partnering with OurCrowd, an Israeli crowdfunding platform, to help local entrepreneurs find funding while bringing Israeli startups to Cincinnati. The partnership was made possible by an undisclosed investment in OurCrowd by the Jewish Foundation of Cincinnati.
Crowdfunding platforms like CircleUp are forming alliances with large companies like Johnson & Johnson. Deals like this afford large companies market intelligence and the ability to build relationships with early-stage companies that may be good acquisition candidates down the road. In return, startups get capital and expertise in scaling their companies.
Only about 3% of accredited investors become angel investors. Because it typically takes about seven years for a tech company to offer an exit for investors, there’s concern that lack of liquidity for early-stage investors may be discouraging investment in this asset class. To address this, so-called “venture exchanges” have been proposed to create a secondary market. Early investors in startups and small businesses could sell their shares on a venture exchange and new investors could buy in and trade these private stocks.
Another approach to increase the number of accredited investors becoming angels is by providing training. Portfolia is doing this. “Expect a wave of tools that lower the cost of doing things, such as legal agreements (like iDisclose) and transparency and due diligence tools like CrowdBureau,” says Wales. I’ll be doing a story on new online tools that will lower legal costs shortly.
“It takes time for any new regulation to show its usefulness,” according to Ellenoff. He believes, as do I, that the sector is off to a very good start, as exemplified by all the recent activity around equity crowdfunding over its first two years.
If you're looking for more information raising capital, continue on to learn the 5 W's of equity startup financing.